Sanctions Carve-Out Bars Coverage for Show Cause Order Issued to Attorney

The United States District Court for the District of Colorado, applying Colorado law, has held that a professional liability insurer was not obligated to defend an attorney accused of discovery misconduct. The court ruled that an order requiring the attorney to show cause why he should not be sanctioned did not seek Damages, as defined in the policy, and fell within an exclusion for claims seeking payment of legal fees and costs. Godin & Baity, LLC v. Markel Ins. Co., Inc., 2020 WL 5076764 (D. Colo. Aug. 27, 2020). The court also addressed and rejected the insured’s “reasonable expectations” argument, as the facts did not satisfy either of the two conditions under which Colorado law recognizes the doctrine.

The insured attorney defended a municipal housing authority accused of failing to provide reasonable accommodations for owners of companion/therapy pets. As framed by the court, the discovery dispute that led to the show cause order arose from a mismatch between the plaintiffs’ attorneys’ “fight-everything, no-motion-left-behind tactics” and the insured attorney’s apparent view that the case was just a “small-town dispute about three plaintiffs, two cats, one dog, and an honest misunderstanding.” Order Discharging Order to Show Cause Against [Insured Attorney] at 16, McFadden v. Meeker Housing Auth., No. 16-cv-02304 (D. Colo. May 21, 2019), ECF No. 500.

The McFadden plaintiffs believed that the insured attorney had failed to disclose documents and possibly permitted his client to alter documents prior to production. The plaintiffs sought entry of default as a sanction, but the judge refused – instead ordering the insured attorney to show cause why he should not be sanctioned by having to pay fees and costs associated with the plaintiffs’ attempts to obtain the discovery to which they were entitled. The insured attorney sought a defense from his professional liability insurer, which denied coverage. Coverage litigation ensued in front of the same judge who was handling the underlying case.

The insurer declined to provide a defense because the policy only provided for a defense against claims seeking Damages, and Damages were defined as not including “fines or penalties [or] sanctions[.]” The insurer also asserted an exclusion for claims seeking “payment of any form of legal fees, related fees, or any other costs, expenses, or charges[.]” The insured countered that, notwithstanding the court’s characterization of the potential payment of fees as a “sanction,” any ordered payment would be “compensatory” damages (which would fall within the definition of Damages) because it would have the effect of compensating plaintiffs for their undue expenditures. The insured attorney argued that the word “sanctions,” as used in the policy, was ambiguous, and that he reasonably expected provision of a defense, at least until it was established that his conduct was sanctionable.

The court rejected these arguments, concluding that the term “sanctions,” though undefined, was unambiguous as applied to the show cause order under consideration and that the argument that the sanctions were compensatory in nature, and therefore potentially covered, was the “type of ‘strained’ interpretation courts avoid.”

The court addressed the “reasonable expectations” argument by first reciting the two “main situations” in which the doctrine is recognized under Colorado law: (1) where an objectively reasonable insured would fail to understand they were not entitled to coverage, in view of the policy language; and (2) where an insurer was responsible for “circumstances” that would “deceive” an objectively reasonable insured into believing coverage would be available. Noting that the insured attorney argued only under the first prong, the court held that there could have been no objectively reasonable expectation of coverage in view of the carve-out from the definition of Damages and the exclusion for claims for payment of fees and costs.



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